A Creative Method To Refinance A Highly Leveraged Property

By Bruce J. Coin

One of the major problems confronting the commercial or income property financing industry is finding a way to finance many of the highly leveraged existing properties that were financed 5, 7 and 10 years ago and their loans are now coming due. Last fall in separate statements issued by both the Mortgage Bankers Association and by Deutsch Bank predicted that approximately $400 billion of existing commercial mortgages will expire and need to be refinanced. Just at the end of January, the Fitch Rating Service predicted that default rates on commercial mortgages could reach 12 percent by 2012 and that those insurance companies that invested in CMBS bonds could lose $20 billion.

Of most concern are the loans that were written by banks or CMBS conduit originators. Many were written at 80% loan to value ratios, with no amortization or with low amortizing 30 year schedules. The interest rates of many of those mortgages are about the same or nominally higher than today’s rates but with appraised values based on much lower capitalization rates and often with appraised values based on assumed higher rents. During the last two years, vacancy rates have increased substantially across all property types as have capitalization rates while loan underwriting standards have become more conservative.

In combination with the substantially reduced dollars available in the market place to finance commercial properties and the more conservative underwriting standards currently being applied by those lenders that are active, prospects for refinancing are currently “dim” for many commercial property owners and has led to more than one professional describing the situation as a potential time bomb of default.

The problem is that it is difficult to find lenders today that will make new loans at more than 70% loan to value ratios and with more conservative underwriting that includes the use of higher vacancy allowances and overall capitalization rates. The lending community sees this and the federal government sees this. All are thinking and hoping that given time more investors will return to financing mortgage product while vacancies decline, existing loans can amortize further and property values will again increase. The fed offered the use of TALF funds to effectively refinance maturing highly rated CMBS product. To stave off defaults some banks are using the “pretend and extend” method of pretending that there is not a current loan to value ratio problem and are extending the loan with the same hopes.

Depending upon the circumstances and with a little aggressive attitude there is a method from the early 1970s that can be employed in the right situation today to refinance some of these properties. By providing a combination land purchase-leaseback and leasehold mortgage transaction collective amounts of up to 85% (and higher if desired) of current property value can be offered as a financing package. It will take a positive attitude by existing lenders and help from their legal staff but an abundant number of similarly structured transactions were successfully used by many of the insurance companies in the late 1960s and early 1970s. Some used the method as a pseudo joint venture structure.

The concept is simple but the mechanics can be complex. The borrower conveys the land of their project to the lending institution or to a subsidiary or holding company if required to meet legal requirements and leases it back at a fixed rent. Simultaneously the lender provides a leasehold mortgage up to its comfort limit of the appraised value, presumably 75% (not 70% or 80%) of the leasehold estate it just created. Remember this is intended to be a “help” not a punish program.

While lenders holding loans from such borrowers may think that the borrower is “stuck” and will accept most any solution that isn’t always the case and the bankruptcy courts are always an option. Taking unfair advantage of a borrower in this market could lead to more trouble than it is worth. Using my suggested idea, a fairness standard should be employed and if “everyone” believes that over time, vacancies will diminish and values will increase (which is highly likely) this is a solution that can allow a deserving borrower to keep equity and earn their way out of difficulty by a combination of good management and an improving economy. It will also give the lender more control and options in the event of a default as an eviction action can be used when the ground rent is defaulted in addition to normal foreclosure procedures on the mortgage.

As an example:

If a property was financed 5 years ago for $4,800,000 as an 80% LTV with a 30 year amortization schedule and 6.75% interest rate the balance of that loan today would be about $4,575,000. The initial appraised value would have been approximately $6,000,000. A 1.25 times debt service coverage ratio indicates that the N.O.I. would have been approximately $467,000 indicating that the overall capitalization rate applied at the time was probably 7.75% or less.

Now let’s assume that between increased vacancy, some tenant rollover and increased operating expenses the property’s N.O.I. declined by 5% to a current level of approximately $ 443,650. Applying an overall capitalization rate today of say 8.0%, the appraised value would only be about $5,545,000 making the current balance equal to about 83% of value which is much higher than is customary or available today.

However, if we say that the land under the building(s) is worth in this example say $1,000,000 (18% of current total value) and do a purchase lease back where the rent is based on say 6.25% for up to 10 years (see below) or $62,500/year the picture changes. After deducting the $62,500 from the $443,650 N.O.I., the income to the leasehold estate is now $381,150 but you only need to provide a leasehold mortgage of $3,575,000 to provide the total of $4,575,000 needed to refinance, notwithstanding fees and closing costs. Applying a 75% LTV ratio to the $3,575,000 indicates that the appraised value of the leasehold would need to be approximately $ 4,767,000 which would be supported today with an overall cap rate of 8.0%. Applying a fixed rate of say 6.75% to that for 7 or 10 years and with a more conservative 25 year amortization produces an annual debt service on the $ 3,575,000 of approximately $296, 403. Including the land rent of $62,500 the overall “debt service” would be approximately $358,903. The N.O.I. of $443,650 reflects an overall d/s coverage ratio of 1.236 times.

The ground lease must contain a repurchase provision that gives the borrower the right to repurchase at any time for the same price. The ground repurchase option can contain a provision that the ground can only be repurchased simultaneously with the prepayment of the leasehold mortgage. Neither the ground lease, purchase option or leasehold mortgage can be assumed by anyone. No “reasonable approval” clause allowed. If a lender is concerned that the 6.25% and 6.75% rates suggested above are too low they may be able to incorporate rent or rate “up-ticks” after say 5 years but only if the property is showing increased income less you again increase the possibility of default, i.e., based on performance. As a “hammer” to force the borrower to ultimately sell or refinance to repay this financing in 10 years or less, the purchase price of the land would be structured to then escalate significantly year to year after that. It is important to note that if such a transaction is structured as above that over 10 years the mortgage, in this example, would amortize by about 21.7% down to about $2,800,000 or $3,800,000 total would be owed including the $1,000,000 for the land. That’s more than ¾ ths of a million dollars less than is owed today.

Obviously, depending on the type of lending institution, there may be some legal hurdles to be overcome but they can be and if a mortgage lender or a borrower is looking for a way out of an impending default situation and they believe that time will ultimately cure the problem this can work but not for every transaction. The numbers need to be studied on a case by case basis as well as the perceived prospects for future success property by property, borrower by borrower before deciding to do this. I’m sure, once this idea is brought to their attention, that some of the CMBS entities that are ramping up and not constrained as are the banks and insurance companies, will quickly find a creative way to employ this technique. All fees and closing costs should be paid by the borrower. In some states transfer taxes on the ground transfer may be an issue but I believe that if such a program can be offered to a borrower that “basically avoids potential for default and gets them out whole” except for the fees and closing costs, they will take such a financing deal as it lets them keep heir property avoid default and earn their way out.

This entry was posted
on Monday, February 8th, 2010 at 11:12 am and is filed under Articles.
You can follow any responses to this entry through the RSS 2.0 feed.
You can leave a response, or trackback from your own site.

Hi there, just was alert to your blog thru Google, and found that it is really informative.
I am going to be careful for brussels. I’ll be grateful
if you continue this in future. Lots of people will be benefited out of your writing.
Cheers!

We’ve examine many nutrients in this article. Certainly value social bookmarking with regard to returning to. I’m wondering the way a great deal effort you determine to build these amazing useful website.

Howdy I am so thrilled I found your site, I really found you by error, while I was searching on Bing for something else, Regardless I am here now and would just like to say thanks for a marvelous post and a all round exciting blog (I also love the theme/design), I don韙 have time to read it all at the moment but I have bookmarked it and also added your RSS feeds, so when I have time I will be back to read much more, Please do keep up the great job.
ugg wellington boots uk http://festamix.com.br/arquivos/image/ugg/9vjugg-wellington-boots-uk44wp.asp

I have to tell you that it’s hard to find your posts in google, i
found this one on 22 spot, you should build some quality backlinks in order to rank your site,
i know how to help you, just type in google – k2 seo tips and tricks

Someone necessarily help to make severely posts I
would state. That is the very first time I frequented
your web page and so far? I surprised with the
research you made to make this particular put up amazing.
Wonderful job!

Nice post. I was checking constantly this blog and I’m inspired! Extremely useful info specifically the last section I handle such info a lot. I used to be looking for this certain information for a long time. Thank you and good luck.

I do agree with all of the ideas you’ve presented in your post. They are very convincing and will definitely work. Still, the posts are very short for starters. Could you please extend them a little from next time? Thanks for the post.

Somebody necessarily lend a hand to make seriously posts I might state. That is the first time I frequented your web page and thus far? I surprised with the analysis you made to create this actual put up amazing. Excellent activity!

I found some interesting things and I will apply to the development of my blog. Thanks for sharing useful information. Your article actually have some great points on that my friends will find this helpful, I must share this to them, Great job!

Thanks for your strategies. One thing we have noticed is the fact that banks and also financial institutions have in mind the spending behaviors of consumers and as well understand that the majority of people max out their credit cards around the holidays. They smartly take advantage of this particular fact and commence flooding your own inbox and also snail-mail box together with hundreds of 0 APR credit cards offers right after the holiday season comes to an end. Knowing that when you are like 98% of all American community, you’ll hop at the chance to consolidate personal credit card debt and move balances towards 0 annual percentage rates credit cards.

I think that what you said made a bunch of sense. But, think on this, suppose you composed a catchier title? I ain’t saying your information isn’t good, however suppose you added a headline that grabbed people’s attention? I mean A Creative Method To Refinance A Highly Leveraged Property Bruce's Blog is kinda plain. You should look at Yahoo’s front page and note how they create post titles to grab people to open the links. You might add a related video or a picture or two to get people excited about everything’ve got to say. Just my opinion, it would make your blog a little livelier.

hello there and thank you for your info – I’ve definitely picked up anything new from right here. I did however expertise several technical issues using this site, since I experienced to reload the site lots of times previous to I could get it to load correctly. I had been wondering if your web host is OK? Not that I’m complaining, but sluggish loading instances times will sometimes affect your placement in google and can damage your quality score if advertising and marketing with Adwords. Anyway I’m adding this RSS to my e-mail and could look out for a lot more of your respective intriguing content. Make sure you update this again very soon..

Hello there, I discovered your blog by the use of Google whilst searching for a similar topic, your website came up, it appears to be like great. I’ve bookmarked to my favourites|added to my bookmarks.

Hey there. I actually want to make a nice short observation and inform you recognize that I’ve been following your particular blogging site for quite some time. Keep up the very extraordinary task and I will be returning again again soon.

For sure I have been known about this for for a while, but now I’m convinced totally. I think it is positive to be informed that and this pleasant post is a big support for each person that is worrying onthat for a second. I will expect that everybodyready to find aditional detailsabout that. Just not everything depends on market capitalization!

Just wanna input on few general things, The website design and style is perfect, the written content is very good. “Drop the question what tomorrow may bring, and count as profit every day that fate allows you.”

After reading this article I was instantly reminded of “When defeat comes, accept it as a signal that your plans are not sound, rebuild those plans, and set sail once more toward your coveted goal.” — Napoleon Hill